"May you live in interesting times . . . "
Yesterday’s announcement of the de-pegging of the Yuan to the US dollar had an immediate impact: Bonds across the yield curve all rose about 10 basis points. As we noted yesterday morning:
"the Real Estate Complex
has been the most robust segment of the U.S. economy. If the Chinese
can succeed (where the Fed failed) in raising U.S. long rates, the
part of the US economy is at risk. While we know real estate had to
the question is how fast will it occur, and how dramatically."
That’s my key takeaway from this entire issue. Why? Because I doubt it will impact exports much — given that the massive wage disparities and cost structure differentials are so significant, a 2% (or even a 12%) currency change won’t amount to a whole lot, relative to imports.
The position I’ve staked out (vis-a-vis Real Estate and the Economy) is decidely in the minority. To reiterate:
1) Real Estate is a very different type of asset than stocks;
2) Housing is not a bubble — rather, it is an extended asset class — and therefore is vulnerable to a 25-35% retracement, as opposed to a Nasdaq like 80% crash;
3) The rest of the economy is mediocre; Back out Housing Related activity, and there’s not a whole lot of there there.
We’ve been beating that drum for many months now. Finally, the meme that Real Estate has been driving the economy has only recently received widespread attention.
So the currency shift, and its resultant impact on long rates (and therefore Real Estate), plays very much into our Bearish 2006 scenario.
Consider the Yuan depegging in light of the increasing number of "exotic" mortgages: 30-Year Fixed mortgages are down to just over 40% from ~70% of all mortgages; Adjustable mortgages, up from under 10% to over 40%; Interest only mortgages, up to 20% — from 0 in 2001.
Its hardly intelligent to take an APR when rates are at half century lows; Interest only mortgage holders don’t really own their homes — they are more like renters with an option to buy. Hey, that’s the free market — people are free to be as dumb a they want to be.
Where it becomes a macro-concern is that all these loans get sold, securitized and packaged, courtesy of
Sallie Fannie Mae and Freddie Mac. If we see a big wave of defaults, that could have deep and far reaching ramifications on the country’s capital markets.
Have a look at a recent WSJ discussion of related topics:
WSJ: ". . . offering alluring and controversial mortgages that require unusually slim payments for a few years, before bigger sums fall due. Some customers use these loans to borrow as much as seven times their annual income — a staggering jump from the two-times-annual-income level that was the rule of thumb when the 30-year fixed-rate mortgage was the norm.
As real-estate mania intensifies, the mortgage industry keeps making it easier to borrow. "Low documentation" loans are catching on, including ones where lenders simply take borrowers’ word about their income and don’t ask for pay stubs. Repayment terms sometimes are stretched as long as 40 years, to help shrink monthly payments. In the most common twist, lenders aren’t requiring even token efforts to repay principal in the early years of a mortgage. Interest-only payments suffice. In some cases, borrowers can even pay less than that, allowing interest to pile up and be repaid later.
Skeptics worry that this easy-credit euphoria could end with a real-estate crash and waves of problem loans. Federal Reserve Board Chairman Alan Greenspan warned in June that housing prices in some areas appeared "unsustainable," adding that he was concerned about "the dramatic increase in the prevalence of interest-only loans." In a recent Wall Street Journal survey of 56 leading economists, 11 named a possible housing bust as their biggest worry for the economy."
Equally disturbing: Most of Wall Street and Washington D.C. have applauded this. So far, I’ve found only myself — and John Rutledge — are overly concerned with the negative impact of this development. At least it will be fascinating to watch how this unfolds over the next 18 months.
Its ironic: "May you live in interesting times" is considered a curse — by the Chinese.
Easy Money: A Mortgage Salesman’s Pitch
Mr. Ray Touts Low Payments For the First Five Years;
Interest Keeps Piling Up A Chance to Buy That Escalade
THE WALL STREET JOURNAL, July 20, 2005; Page A1
Washington, Wall Street React To Chinese Yuan Revaluation
July 21, 2005 1:26 p.m.